Could China Trade Initiative Lead to Higher U.S. Interest Rates and Higher Stock Prices?
By William Patalon III
Managing Editor
China is moving to tame its out-of-control trade surplus – but not in the way U.S. leaders wanted to see.
Even so, here’s an interest paradox to contemplate.
While this particular trade strategy by China could end up with U.S. investors facing higher interest rates, those Fed-engineered rate increases won’t necessarily send stocks into a nosedive.
Indeed, over the long haul, could it possibly even help send U.S. stocks toward higher ground?
Let’s take a look;..
Because China’s trade surplus with the United States has been soaring out of sight, the Bush Administration and U.S. trade officials have been pushing China to allow for a much-faster increase in the value of its currency, the Yuan.
China’s trade surplus with the United States was $22.5 billion for May, an increase of 73% from the year before. So far this year, the cumulative surplus is up 83% to nearly $86 billion.
Surpluses like this one are a big reason that China right now has $1.2 trillion in foreign reserves. That’s a huge number and is one that has many economists living in fear of a recession that starts in the United States and then spreads throughout the world. If the United States can’t finance this growing shortfall, interest rates will soar and economic growth will stall.
Partly in response to such worries, China revalued its currency in July 2005, ending a decade-long link to the U.S. dollar. The move did result in a rising Yuan, which was supposed to throttle back U.S. purchases of China’s goods.
The reason is simple: If the Yuan rises in value against the dollar, that means the dollar can’t purchase as many of the Yuan-priced items as before. That reduces trade and slows the growth rate of the U.S. deficit with China.
As we can see, however, it really hasn’t worked. And China’s trade surplus continuing to soar, U.S. officials want to see an even faster-appreciation in the Yuan.
Instead of that, however, China just said it will restrain exports by either reducing or eliminating tax rebates on about 40% of its export wares. The changes in the export rebates take effect July 1, but make no mistake: This is a much-less powerful tool than a higher currency valuation.
Goldman Sachs said that this unilateral increase in export tax rebates without an accompanying cut in import taxes is like China increasing its currency valuation, but then also increasing tariffs on imports.
Besides, other trade experts say, there are lots of loopholes China’s exporters can use to get around any detrimental financial impacts.
So we’ll keep buying China’s goods, and China’s foreign-reserves will continue to grow.
The Fed may well move to raise interest rates if its worries about this situation continue to escalate.
But we’re forgetting something here: All this doesn’t account for the fact that China has to do something with all that cash.
And we’ve already seen part of what’s to come.
Last week’s IPO of a private-equity heavyweight, The Blackstone Group, is a great example of what I mean. Several months ago, a newly created state-run investment arm of the Chinese government invested $3 billion in Blackstone, helping capitalize that buyout firm’s search for bankable deals.
Blackstone went public in a $4.1 billion IPO last Friday.
That $3 billion investment was just the start of China’s efforts to deploy some of its cash. You’ll start to see China – either directly via its government buyout arm, or more indirectly, via China-based corporations – acquire companies, business divisions, real estate, or other U.S. assets.
What many folks don’t realize is that such moves help the United States finance its trade deficit. We sell off assets, and through that raise money to offset the money we borrowed to purchase the imports. That’s an oversimplification, but it’s basically how things work.
China is also liberalizing its investment rules, too. So it won’t be long before some of China’s growing middle class is investing in the likes of GE, Microsoft, Intel, P&G – and in the smaller, more-speculative firms that cause all investors to feel their pulses quicken.
As we say all the time here at Money Morning: Money moves markets. So whether it is Chinese government funds or private buyout funds from Shanghai buying stakes in our companies, or just buying these companies outright, that flow of capital from China will help send stock prices here higher. Add in the liquidity from China’s retail investors;and you quite possibly have the recipe for a continued increase in stock prices.
Even with those higher U.S. interest rates.
